Navigating Brophy Claims: Rule 10b5-1 Plans, Trading Windows, and the Complexities of Material Nonpublic Information

Corporate insiders with access to material nonpublic information (MNPI) find themselves in a precarious position when engaging in the routine act of selling shares. Each transaction carries the threat that legitimate trading could give rise to claims for insider trading. While mechanisms like Rule 10b5-1 plans offer a potential buffer against securities fraud claims in the federal system at the pleading stage, their applicability and protective power in Delaware remain shrouded in uncertainty. This ambiguity leaves insiders navigating a legal minefield, where the stakes include costly litigation and reputational harm.

This article delves into the complexities surrounding Brophy claims—Delaware’s version of an insider trading claim—named after the landmark case Brophy v. Cities Service Co., 70 A.2d 5 (Del. Ch. 1949). First, the exculpatory effect of 10b5-1 plans in Delaware is examined, including whether these plans can provide the same early dismissal opportunities as in federal courts. Next, the strategic importance of defining trading windows is analyzed, emphasizing how their length correlates with the viability of insider trading claims. Finally, the challenge of identifying MNPI is addressed, a critical factor in assessing the strength of insider trading claims. By unpacking these issues, we hope to provide readers with insights to navigate this intricate legal landscape.

10b5-1 Plans at the Pleading Stage: What Do They Offer?

Defendants facing securities fraud and insider trading claims under the Securities Exchange Act of 1934 (the Exchange Act) can leverage Rule 10b5-1 plans at the pleading stage to help defeat such claims. By contrast, Delaware courts have not addressed the impact of 10b5-1 plans on Brophy claims. As a result, the exculpatory effect of these plans at the pleading stage in Delaware remains unknown.

10b5-1 trading plans

Rule 10b5-1, adopted by the Securities and Exchange Commission in 2000 and amended in 2022, enables company insiders to sell company stock without violating the Exchange Act by establishing a trading plan that predetermines the number of shares and the time of sale. 17 C.F.R. § 240.10b5-1, as amended, 87 Fed. Reg. 80,429 (Dec. 29, 2022). A plan must be established when the insider does not possess MNPI and must either specify the amount, price, and date of trades or provide a formula or algorithm for determining these details.

Effective February 2023, amendments to Rule 10b5-1 restrict persons, other than the company itself, from having more than one trading plan at a time, with a few narrow exceptions. In addition, these amendments impose an ongoing good-faith requirement for the duration of the plan, instead of only at the time of entry into the plan. The amendments also require a “cooling-off” period between when the plan is adopted or modified and the start of trading. The cooling-off period for directors and officers ranges from 90 to 120 days, while all other insiders are subject to a 30-day period. Pursuant to the amendments, directors and officers must include in the 10b5-1 plan written representations that the adopter is not aware of MNPI about the issuer or its securities and is adopting or modifying the plan in good faith.

A properly established 10b5-1 plan provides an affirmative defense against insider trading claims brought pursuant to the Exchange Act. In addition, federal courts have recognized that 10b5-1 plans have a role to play in litigation at the pleading stage. In the context of assessing motions to dismiss securities fraud claims brought under Exchange Act section 10(b), some federal courts have recognized that trades made pursuant to 10b5-1 plans generally do not give rise to a strong inference of scienter. See, e.g., Ark. Pub. Emps. Ret. Sys. v. Bristol-Myers Squibb Co., 28 F.4th 343, 355–56 (2d Cir. 2022). Similarly, federal courts assessing insider trading claims under Exchange Act section 20A have noted at the pleading stage that trades made pursuant to a 10b5-1 plan may negate an inference that those trades were made with the requisite scienter. See In re Countrywide Fin. Corp. Sec. Litig., 2009 WL 943271, at *4 (C.D. Cal. Apr. 6, 2009).

The uncertain exculpatory effect of 10b5-1 plans in Delaware

Brophy claims and 10b5-1 plans have coexisted for decades. However, no Delaware opinion has dismissed a Brophy claim at the pleading stage based, in part or in whole, on such a plan. Instead, where the Delaware Court of Chancery has dismissed claims involving 10b5-1 plans, it has relied on other grounds independent of the plans. See, e.g., Tilden v. Cunningham, 2018 WL 5307706, at *20 (Del. Ch. Oct. 26, 2018); In re Camping World Holdings, Inc. S’holder Derivative Litig., 2022 WL 288152, at *8 (Del. Ch. Jan. 31, 2022), aff’d, 285 A.3d 1204 (Del. 2022).

Without express judicial guidance from Delaware courts on the exculpatory effect of 10b5-1 plans at the pleading stage, insiders facing a Brophy claim are placed in a difficult position. They lack a clear way to deploy 10b5-1 trading plans to win dismissal of Brophy claims at the pleading stage, leading to uncertainty in assessing potential legal liability and costs from a trade. Insiders often need to conduct stock sales that can attract plaintiffs’ attention and trigger books-and-records and litigation demands under the Delaware General Corporation Law, which can result in time-consuming and costly Delaware litigation.

A framework that Delaware law should support

Delaware courts’ silence on the pleading-stage effect of 10b5-1 plans is surprising given the existence of early-dismissal opportunities in other situations, like where a controlling stockholder properly discloses and cedes decision-making authority to a disinterested party.

The paradigmatic example is In re MFW Shareholders Litigation, 67 A.3d 496 (Del. Ch. 2013), aff’d, 88 A.3d 635 (Del. 2014), in which the Delaware Supreme Court affirmed that dual procedural safeguards—specifically establishing an independent special committee and requiring a majority-of-the-minority vote—can effectively address loyalty concerns inherent in dealing with a conflicted controller. In MFW, the Court of Chancery concluded that when these stockholder-protective safeguards are put in place, the deferential business judgment rule applies, rather than the exacting entire fairness standard that otherwise applies to controller transactions. Id. at 524–25, 535–36. Recently proposed amendments to the Delaware General Corporation Law aim to expand the use of cleansing mechanisms, including those established in MFW, highlighting Delaware’s interest in providing certainty and predictability.

The rationale behind 10b5-1 plans is similar to that in MFW—10b5-1 plans disclose the seller’s interests and remove decision-making authority from him or her. See 17 C.F.R. § 240.10b5-1(c). It is worth considering why these safeguards should not operate similarly to MFW at the pleading stage in the Delaware Court of Chancery. Like the procedural protections of MFW, 10b5-1 plans need not grant blanket immunity at the pleading stage. Instead, 10b5-1 plans could offer a safe harbor where the court applies a rebuttable presumption of good faith to insider trades made according to compliant plans. This approach would enhance predictability in Delaware law by ensuring that legitimate trading activities are not unduly hindered by litigation risk and also encourage widespread use of 10b5-1 plans.

Delaware’s Stance on Trading Windows: Long Trading Windows Face Long Odds

Defendants have successfully countered Brophy claims at the pleading stage by challenging the breadth and duration of the alleged trading window, i.e., the period of time when the alleged insider trading took place. Overly broad windows tend to fail the Brophy pleading requirement that mandates pleading that each individual possessed MNPI at the time of each individual trade. See Camping World, 2022 WL 288152, at *11. The result is that defining the trading window takes on an important role in the viability of a Brophy claim.

The effect of trading window length on Brophy claim viability

A discernible principle emerges from recent Brophy decisions: The likelihood of a claim surviving a motion to dismiss is inversely proportional to the length of the alleged insider trading window. Specifically, claims associated with more protracted trading windows, extending from three months to over two years, are more susceptible to dismissal. See, e.g., Guttman v. Huang, 823 A.2d 492, 505 (Del. Ch. 2003) (29-month window); Camping World, 2022 WL 288152, at *12 (22-month window); Rattner v. Bidzos, 2003 WL 22284323, at *12 (Del. Ch. Sept. 30, 2003) (10-month window); In re Clovis Oncology, Inc. Derivative Litig., 2019 WL 4850188, at *16 (Del. Ch. Oct. 1, 2019) (8-month window); Tilden, 2018 WL 5307706, at *20 (3-month window); In re TrueCar, Inc. S’holder Derivative Litig., 2020 WL 5816761, at *26 (Del. Ch. Sept. 30, 2020) (3-month window). Conversely, claims predicated on shorter trading windows—ranging from a few days to two weeks—demonstrate a higher propensity to withstand dismissal motions. See, e.g., In re Fitbit, Inc. S’holder Derivative Litig., 2018 WL 6587159, at *17 (Del. Ch. Dec. 14, 2018) (two 1-day trading windows); Silverberg v. Gold, 2013 WL 6859282, at *16 (Del. Ch. Dec. 31, 2013) (8-day trading window); Goldstein v. Denner, 2022 WL 1797224, at *9 (Del. Ch. June 2, 2022) (11-day trading window).

Strategic considerations in defining trading windows

While Delaware courts appear skeptical of Brophy claims casting a wide net with trading windows, and the Court of Chancery has concluded that a one-month window “detracts” from the conceivability of a Brophy claim (Rattner, 2003 WL 22284323, at *10), the court has not yet expressly addressed this issue. Delaware should follow the federal courts on this point, which have held that a lengthy trading window “weakens” an inference of scienter. Tchrs.’ Ret. Sys. of La. v. Hunter, 477 F.3d 162, 185 (4th Cir. 2007) (“Alleging such a lengthy class period weakens any inference of scienter that could be drawn from the timing of defendants’ trades.”); In re Hertz Glob. Holdings Inc., 905 F.3d 106, 120 (3d Cir. 2018) (holding that 29-month trading window “cautions against inferring scienter” because “a lengthy class period makes it difficult to infer intent from the mere fact of a stock sale”); see also In re Oracle Corp., 867 A.2d 904, 934 (Del. Ch. 2004), aff’d, 872 A.2d 960 (Del. 2005) (holding that Brophy elements “more or less track the key requirements to recover against an insider under federal law”).

And when cases with unclear and lengthy trading windows have survived dismissal in Delaware, they involved large federal investigations or highly publicized macroeconomic events like a financial crisis. See, e.g., In re Am. Int’l Grp., Inc., 965 A.2d 763, 782 (Del. Ch. 2009) (nearly five-year trading window, but the MNPI related to fraudulent schemes around the time of a financial crisis); Pfeiffer v. Toll, 989 A.2d 683, 689 (Del. Ch. 2010), rev’d on other grounds, 23 A.3d 831 (Del. 2011) (months-long trading window but the MNPI related to financial projections around the time of a housing bubble). These exceptions themselves underscore the general trend: that broader trading windows—absent an exceptional set of facts like a global financial crisis—provide difficult footing for plaintiffs to survive a motion to dismiss.

While defendants can leverage these arguments to their advantage, they cannot dictate the trading window. Plaintiffs, on the other hand, can define this window, giving them more flexibility to frame their claims.

MNPI Mystery: How Can a Company Know It Is Dealing with MNPI?

Whether the focus is on 10b5-1 plans or the alleged trading window, MNPI is central to assessing a Brophy claim’s viability at the pleading stage. For 10b5-1 plans, the inquiry is whether the insider had MNPI when entering into the plan; and for trading windows, the question is whether the insider had MNPI at the time of each challenged trade. Unsurprisingly, a key question is this: What constitutes MNPI?

Understanding MNPI through recent Brophy cases

Recent cases denying motions to dismiss Brophy claims clarify what courts may consider to be MNPI. By analyzing these cases, companies can better grasp what information may qualify as MNPI, which is essential for strategies to mitigate Brophy claim risks.

• Eroding capital and production delays: information about a company’s declining capital and production delays. Transcript of Record, In re Nikola Corp. Derivative Litig., C.A. No. 2022-0023-KSJM, at 47 (Del. Ch. Apr. 9, 2024).
• Key financial projections: information about gain-on-sale margin projections being 3.5 percent to 3.19 percent lower than previously reported. Transcript of Record, In re Rocket Cos., Inc. S’Holder Derivative Litig, C.A. No. 2021-1021-KSJM, at 18 (Del. Ch. Mar. 1, 2023).
• Takeover interest: information about a company’s acquisition interest at a 64 percent market premium. Denner, 2022 WL 1797224, at *2.
• Risks to key revenue sources: information about a program contributing 25 percent of profits, which was at risk of termination or modification. Transcript of Record, Macomb Cnty. Emps.’ Ret. Sys. v. McBride, C.A. No. 2019-0658-AGC, at 23 (Del. Ch. Mar. 9, 2021).

Navigating MNPI challenges with legal guidance

At bottom, identifying MNPI is inherently difficult, requiring careful evaluation of multiple factors, including the company’s products or services, the competitive landscape and industry, and customer and investor bases. Companies and insiders should exercise caution in trading practices and consult legal counsel to navigate the complexities of Brophy claims. By leveraging insights from recent cases and understanding available procedural frameworks, they can better prepare for Brophy claims, thereby increasing the likelihood of dismissal at the pleading stage. The nuanced nature of MNPI and the evolving legal landscape necessitate a proactive approach to compliance and risk management. Vigilant companies, informed by capable counsel, provide the best defense against insider trading liability.